Best TSP Funds

Part 2

Avoiding Losses

Best TSP Funds

The last bear market in stocks lost more than all the gains of the preceding bull market.  Kind of silly to give all of your gains back and start over again, but this is what buy and hold is all about. Meanwhile the TSP G fund will continue plodding higher during periods of financial stress and rising interest rates. In other words, the TSP G fund will significantly outperform equity funds during bear markets.

I do not advocate speculation in retirement accounts or “timing” the market in the traditional sense of jumping in or out.  I also do not advocate buy and hold when the evidence builds up that the bull market is coming to an end and a bear market is commencing.   It is more important for your nest egg to miss some of the gains near the top than to ride the bear market down, period.

But before we talk about where we are in the current market cycle, let’s discuss the major advantages and disadvantages of the TSP C and S fund.

TSP C fund versus S fund

The TSP C fund and S fund are not some special fund that only TSP account holders are allowed to invest in.  These funds are invested in much larger funds that track either the SP500 index and what I call the non-sp500 index.  The SP500 index invests in the largest 500 companies listed on the US exchanges.  The TSP S fund invests in the other 3300 US listed companies not in the SP500 hence we named it the “non-sp500” index.

Weightings matter to allocation levels

While the S fund has more companies, these stocks combined account for about 20% of the total US stock market value.  The SP500 accounts for the other 80% of value listed in the US stock exchanges. 

Which brings up a mistake some investors make. If you want to diversify into the total US stock market you have to hold 4 parts C fund and 1 part S fund.  If you go 50/50 you are leaning heavily to small cap stocks because of market value weightings. Which may be okay, but it is good to understand you are doing this.

Remember the SP500 companies obtain 31% of their revenue outside the US, meaning the SP500 is already diversified internationally.  The SP500 tech sector obtains 60% of its tech revenue outside the US!  When you mix in the I fund, you are quickly over-weighting international revenue and under-weighting tech.

If you go 33/33/33 with a C/S/I mix, you are under-weighting the tech sector, over-weighting international finance and over-weighting small cap stock in the US.  In this case your large cap tech sector weighting is only 11% compared to 26% in the TSP C fund.  A return killer in the past and the future.

Stick with the US equity funds.

So which is best - the C or S fund?

To keep it simple, the performance of the two funds depend where we are in a market cycle.  I'm not talking about the economy's business cycle, but actual stock market cycle - bull and bear markets. 

The small cap fund is more volatile which really means it gains more during market rallies and it loses more during market corrections.  So if we are nearing a market top it is better to be in the large cap funds (TSP C fund) and if we are coming off a market bottom we would tilt toward the S fund. Okay, I know the hard part is determining where we are in the cycles.  We will get to that.

Contrary to popular belief the TSP S fund has under-performed the TSP C fund since 2011.  Many believe the small companies in the S fund outperform the larger cap TSP C fund.  What is misleading is all the funds were given a starting value of 10.0 in 2003 and since that particular date the S fund has out-performed all the other funds. 

In 2003 the stock market was in the process of bottoming due to the 2000 stock market bubble bust. If they set the price to 10.0 a year later in 2004, the C and S fund would basically be in a tie for best performer as of 2018. Note in this chart that both funds move together, but at slightly different rates at different times.  This means they are highly correlated and diversifying into both of them only changes your returns slightly over time.

Bull/Bear Market Volatility

So the critical factor in determining allocations is to know approximately where we are in the larger bull/bear market cycle.  As we close in on a top, you should shift from the S fund to the C fund for safety.  In many cases other smart investors are doing the same as a defensive measure and the large cap C fund outperforms the small caps as the market slowly rolls over.  

You should also begin shifting out of the equity funds into the TSP G fund to avoid the larger market draw downs and preserve our nest egg to invest another day when future returns are more assured. The problem of course is some of the largest gains occur near the end of the bull market.  And of course, the news is all positive and investors are all-in.  

The Hard Part

The most important decision you have to make is when to shift your allocations between either of the US equity funds and the TSP G fund. Equity funds (stocks) come with significant downside risks (ie. losses) during bear markets or large market corrections. Even young investors should sit in the TSP G fund while waiting out market resets.  

Yes, young investors have time to make up for losses, but why would you want to?  I completely reject this mainstream justification for buy and hold.  It serves the financial system, not you. Buy and hope and wait for it to come back up is not a strategy. 

The most important action you can take to ensure the largest nest egg is simply to not ride a bear market to the bottom, period. Unfortunately most financial advisers feel safer by running with the crowd.  That way when the bear market hits, they can tell you no one saw it coming and everyone else lost money too. And the reason this works, is because the market spends 80% of its time in a bull (rising) market.  The problem is it tends to lose most of those gains in the other 20%.

One more page

Following this logic let's look at Best TSP Allocation for 2018

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